Tuesday, 26 June 2012

The Millionaire Next Door (US)

'The Millionaire Next Door' was the result of a fascinating piece of social research into US millionaire households, trying to understand if there are any 'secrets' that can help the rest of us. The authors - Thomas Stanely and Willam Danko - spent 20 years interviewing members of this elite club and found some surprising characteristics. The resulting book was a New York Times Best Seller for over three years. For a summary and excerpts, see here and here - also the book's website.

Some of the findings are very relevant to a DIY Income Investor.
'Wealth' is defined in the study as net worth or assets less liabilities. The research found that only about 3.5% of all US households are in the million-dollar net worth league. Almost all of these millionaire households (95%) are composed of married couples - but most of the wealth seems to have been generated by men - in 70% of married millionaire couples, the male head of the household contributed at least 80% of the income.

However, most US millionaire households are not super-rich: 90% percent have a net worth between $1-10 million.

The most interesting finding is that most US millionaires are self-made - rather than being inheritors of wealth. The overall conclusion of the study was that:

Building wealth takes discipline, sacrifice, and hard work

When the authors investigated how people become wealthy, they found something really odd - there seemed to be a mismatch between wealth and lifestyle. For example, many of the people who live in expensive neighbourhoods and drive luxurious cars do not have extreme wealth, while many people who have great wealth do not live in expensive neighbourhoods.

The underlying truth is that what you can do to become wealthy (and how wealthy you become) is not related to what you spend but what you accumulate. (This is a fundamental concept, described in this blog as the Wealth Potential)
Common features of millionaire households

During the author’s investigation, they discovered seven common denominators among the people who become wealthy:
  1. They live well below their means
  2. They allocate their time and money efficiently, in ways conducive to building wealth
  3. They believe that financial independence is more important than displaying high social status
  4. Their parents did not provide much financial support (most did not receive an inheritance) 
  5. Their adult children are economically self-sufficient
  6. They are proficient in targeting market opportunities
  7. They chose the right occupation
How millionaire households invest
Some of the particular characteristics of millionaire households that are particularly relevant to a DIY Income Investor are:
  • on average they invest nearly 20% of household income (and most invest at least 15%)
  • most (79%) have at least one account with a brokerage firm
  • most make their own investment decisions
  • total annual realised income is less that 7% of wealth (i.e. they live on less than 7% of wealth)
  • nearly all are home-owners

Are you an accumulator of wealth?

Millionaire households got that way mainly by accumulating wealth. Even now, you may be wealthier than you think! Many UK homeowners (particularly in the South East) are already dollar millionaires. 'Net worth' will include all your assets, such as any property you own (less any outstanding mortgage) and financial assets, such as savings and investments. Your pension funds or earned rights may well be a significant component of your wealth - you should be able to determine the value of your pension fund. (For UK readers with 'defined contribution' pensions, take the fund value; for 'defined benefit' pensions, your employer should give you an equivalent pension fund value - typically something like 20 times your annual pension entitlement).
Although you may not (yet) be a dollar millionaire, you might be on the way. The authors give an interesting rule of thumb to estimate how much of an 'accumulator of wealth' you are:
  • estimate your 'net worth', excluding any inherited wealth
  • estimate annual household pre-tax income (if you are retired, use your income in your last working year)
  • multiply your annual household income by your age and then divide by 10
  • your net worth should be greater than this: if it is more than twice this amount, give yourself a gold star - the book says you can call yourself a 'prodigious accumulator of wealth'

My own result is nearly 4 times the criterion - so I reckon I am doing something right. How about you?

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

1 comment:

  1. Yes, 5 times at 60 years old. But, I've suffered some horrendous (investing) losses in my life... balanced by some pretty good (and lucky) gains as in the Tech Boom from 1995 to 2000.